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Currencies Pointing to a Pause in the Equity Rally, but Nothing Serious


A possible rise in the yen in the short term has the bulls keeping the champagne bottles put away for now.

Before I jump into a look at the key gauges of risk in the currency markets, I wanted to take a look at a couple of currencies that will be driven by headlines today.

The pound futures are oversold and at possible support, but appear to have more downside work to do eventually.

We saw British home prices come out better than expected, industrial and manufacturing production and trade balance come out far worse than expected, and are still waiting on a GDP estimate later this morning. The dominant numbers so far appear to have been the weak production and trade balance numbers early this morning as the pound is trading off noticeably this morning.

Given how oversold the pound appears to be on the weekly chart below, I would be looking for a short-term rally to around 1.52 or so before aggressively betting on pound weakness. The eventual target for the pound is all the way down at 1.3805, but possible short-term support comes into play at 1.4775 – just below current levels. If and when that level is taken out on the downside, I will have my confirmation that the pound is headed down to my targets. So, I would remain in "sell the rips mode" for the pound until further notice.

Canadian housing starts data are due out with the Canadian dollar oversold and due for a little bounce. Whatever bounce occurs, though, should lead to more downside.

This morning, Canadian housing starts data will be released. The expectations are for a month-over-month decline – but nothing overly concerning for the bulls on the Canadian economy.

As the release of this data is approaching, the futures for the Canadian dollar (@CD – shown below on a weekly basis) are hitting very oversold levels – meaning a bounce may occur at any point. However, the CD futures still have more work to do on the downside before any major up move may occur.

So, I would be using any bounce up to around 0.9600 to sell or short into and I would be looking to cover those shorts and/or make serious long-side plays at around 0.9325. When it comes time to go long the Canadian dollar, I would be looking to short the USDCAD or go long the CADJPY if I were not playing the futures contracts directly.

Now, onto our regular check-in on the key risk gauges in the currency markets.

The yen is nearing a point where a counter-trend rally may occur.

The Japanese yen futures may have one more bounce for the bears to endure before the macro downtrend resumes. The yen appears to this analyst to be approaching the end of wave "B" of the "ABC" correction that will make up wave 4 on the chart. My projected support for this move lower should come in at 0.9786 for the Japanese yen futures contracts. The proximity to support and the oversold Williams %R reading give me a higher degree of confidence in my short-term bullish opinion. Once that support level is tested, I am anticipating a move up to around 1.0750 for wave "C" of the upside correction. The wave "C" move appears to be very tradable on a reward to risk basis as long as entries are made as close to support as possible (so that a stop-loss is not too painful if it occurs). As mentioned earlier in this article, I would likely favor shorting EURJPY if I were to play the currencies directly instead of via the futures contracts.

A short-term rally in the yen may, if recent relationships hold true, coincide with a short-term correction in risk assets – namely equities.

The dreaded "head and shoulders" topping formation is actually coming to fruition for the euro bears.

A recent break of "neckline" support at around 1.2800 opened up the door for an intermediate-term move to 1.1800 – 1.1900. With the futures contracts on the euro trading at just above 1.2800, a move down to 1.1800 - 1.1900 seems like a long way down. However, such a move (in either direction) is not unprecedented at all. We just saw such a move occur during the first quarter of this year.

Right now, the EC contracts appear to be in wave "3 of III" to the downside. While the wave "III" target is down at the aforementioned target range, wave 3's target is down at the 1.2400 - 1.2500 range – still a nice move lower from current levels. However, the ideal trade would be to wait for more of a bounce (perhaps up to 1.3000 – 1.3100) to initiate or add to short positions (probably via EURUSD or EURJPY if not via the futures contracts).

So if we take the potential for an oversold bounce to occur in the euro and combine that with the potential for the yen to go through a wave "C" upside move in the short-term, we could easily see some corresponding weakness in the US dollar here in the short-term. Let's take a look at the chart of the greenback to see if it echoes this sentiment.

The US dollar is trading right at a crossroads; either the greenback will blow through resistance or it will retest the June lows.

The recent rise in interest rates here in the US has pushed the US dollar futures (@DX) right up to key resistance. Either it will break out above that resistance (likely due to a continued rise in rates – if it occurs), or we will see some major consolidating / backing and filling before the buck makes its breakout move. The chart below shows what the latter scenario may look like.

In this scenario, the DX futures just completed wave "(c) & b" higher and is now commencing wave "c" lower with a trading target at the June lows below 81. Can this scenario really play out? If the euro and the yen are both in short-term bounce mode – absolutely.

So, a weak greenback (risk on), a strong euro (risk on), and a strong yen (risk off)? This scenario could absolutely play out. Add to that the likelihood of some oversold bounces to occur in the Aussie and Canadian dollars and you've got a bullish-leaning currency picture overall – with the caveat that yen strength can possibly override a lot of that. Overall, if things play out as I have laid them out, there are enough cross-currents there to cause just a minor consolidation phase or pullback in equities rather than a major correction. We shall see.

Twitter: @seachangereport

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